Audio 3:14
European Central Bank drops interest rates below zero

Pat McGrathUpdated
Fri 6 Jun 2014, 8:56 AM AEST

The European Central Bank has taken drastic steps to stimulate the eurozone economy. As expected, it has cut the monetary bloc's key interest rate to a new historic low.And in a surprising move aimed at combating deflation of the euro, it's imposing negative interest rates on deposits that it holds.

Transcript

CHRIS UHLMANN: The European Central Bank (ECB) has taken drastic steps to stimulate the eurozone economy. As expected, it's cut the monetary bloc's key interest rate to a new historic low. And in a surprising move aimed at combating deflation it's imposing negative interest rates on deposits that it holds.

For more I'm joined by our business reporter, Pat McGrath. And Pat, what has the European Central Bank announced overnight?

PAT MCGRATH: Well, Chris, just when we thought the eurozone debt crisis was fading, there are now more signs and really a reminder of the threat that it poses to the global economy. So Europe Central Bank has announced that it's taking the unprecedented step of introducing a negative interest rate on the deposits that it holds in its vaults, so leftover money from big banks that are deposited with the central bank.

And this sounds like a fairly complicated arrangement but it's actually fairly straightforward. So instead of paying interest on the deposits, the ECB will start charging banks and other institutions a small rate of interest.

And this is basically designed to act as a disincentive for those depositors to leave money sitting there and growing in value. And if it all goes to plan, it means there will be more euros floating around in the economy and that in turn means the euro's value will fall and it's aimed to address this threat of price deflation that's been on the horizon for some time in the eurozone.

Now at a press conference last night, the central bank's president Mario Draghi was asked whether the bank is considering other measures such as the so-called quantitative easing which the US has used, the so-called money printing program. And he appeared to leave the door open for such a measure in the future.

MARIO DRAGHI: The package has basically three parts. The first part is to ease the monetary policy stance, the second part is to enhance the transmission to the real economy, and the third part is the reaffirmation that we'll also use unconventional instruments if needed.

CHRIS UHLMANN: European Central Bank president Mario Draghi.

Pat, why is deflation seen as a problem?

PAT MCGRATH: Well, Chris, like any economic concept there is a fair bit of disagreement about that, but in the eurozone inflation is currently below 1 per cent and that raises the prospect of prices actually falling at some point. And while that might be welcomed by some consumers, it has some pretty serious economic implications - so exporting goods becomes more expensive, people tend to spend less and save more money, and the real cost of debt increases along with the value of currency.

And that's really the last thing that the eurozone and the world really needs and in the past few months has really served as a reminder that the European debt crisis isn't over yet.

CHRIS UHLMANN: And how have the markets reacted?

PAT MCGRATH: Well, it's been pretty underwhelming really. On the European markets, they've lifted a little bit in the past few hours but the euro, as the ECB will be pleased to have seen, has fallen in value. It's been bouncing around a little bit against the Australian dollar but of course the Australian dollar has been quite strong against most currencies for some time.